Alan Knitowski: Failing to Choose the Right Corporate Structure

GUEST MENTOR Alan Knitowski, founder of Phunware: As a seasoned serial entrepreneur, over the past decade and a half, I have been fortunate to take a close look at many young companies. Some have been absolutely amazing, some have been good, some have been bad and some have been unbelievably ugly — but all have been immensely valuable.

While there are any number of mistakes that you can make during your current quest of company-building, I expect that the most likely mistakes that you will make as a startup founder during 2013 will fall in to the categories of formation mistakes, scaling mistakes and financial mistakes. It would be easy to write an individual article about all of these … and also to add a lot of additional categories on top for middle and later stage companies … but this should (hopefully) provide a good reference to hone your early thinking about both the opportunities and challenges ahead of you as you build out the next Fortune 500 company for others like me to emulate.

Here are the top-five mistakes entrepreneur’s make when forming their company.

Failing to choose the right corporate structure. For whatever reason, far too many companies are, from Day 1, adopting the wrong corporate structure. LLCs and LPs are intended for accountants, lawyers, funds and families while S-corporations are inherently structured for a few partners that never want to show an annual profit and that also want to flow their monetary operating surpluses to themselves as ordinary income.

The correct answer is virtually always a Delaware C-corporation because of both the legal protections provided in Delaware for directors and officers and the underlying intent for the company to eventually make profit and monetize both investment and equity via capital gains (ideally long-term capital gains).

Failing to select the right law firm. There are lots of opinions, but the gold standard for young companies with big dreams is Wilson Sonsini Goodrich & Rosati out of Palo Alto, California, in the heart of Silicon Valley. If you trace the roots and lineage of many of the largest and most envied brands in the world, you will often find WSGR at the core. WSGR is founder-friendly, puts its proverbial money where its mouth is via its WS Investments partners fund, and ensures that corporate structures are always clean, investable and optimized for maximum results with minimal headaches or oversights. A great lawyer will keep you out of trouble and will connect you to the ecosystem needed to accelerate and ramp up your business.

Failing to structure the initial capitalization table correctly. Founders are often far too greedy for their own good, failing to realize that creating a big company requires a lot of talent. You must have great employees, advisers, directors and investors, to name a few. In all my years of building new companies, our founding team has never even owned 50% of even one company at the starting point of the build.

It is far better to own a smaller percent of a bigger pie than 100% or a majority of nothing. Your initial capitalization matrix should include not only founding stock, but also the expected allocations for both your Series A Preferred Stock investors and your employees, directors and advisers via an Employee Stock Option Plan (ESOP). Fully diluted capitalization tables should be comprehensive, and should account for the needs of your business for at least the first 18 to 24 months, at minimum.

Failing to understand the myth of control. Everyone seems to believe that ownership percentages dictate control in a business. While there is some truth to this, the underlying reality is that you have ceded control of your business the instant that you choose to take even one dollar from a third party. Ultimately, people are giving you a $1 because they want $10 or more back at a later time.

Understand and embrace this up front, and you will find that you’ll be better off for it. Whether you view your company as your “baby” or not, always understand that the business is more important than you are, and that you are simply a steward of the business for the greater benefit of all stakeholders.

Failing to create corporate governance. Checks and balances are important in everything that you do in a young company. As with our founding forefathers’ structuring of the Executive, Legislative and Judicial branches of the U.S. government, it’s extremely useful to plan for strong corporate governance as you kick off your new venture.

Oversight breeds discipline, and discipline breeds both operational results and success. Find talented, independent third parties to serve on your board of directors, and have them assist you with audit, compensation, nomination and governance matters, including fundraising, channel-building — and anything else you can pull them into along the way.

Conduct board meetings monthly for the first several years of your business, and embrace strategic planning and financial accountability so that you’ll make the most of the capital that you have in order to execute your vision and limit the potential for failure — which is, statistically, the most likely outcome for your venture once started.

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